Stockwatch: share price is down, but this company is not out
A boardroom battle is underway, but signs are the business is on the cusp of better times financially.
7th July 2020 12:18
by Edmond Jackson from interactive investor
A boardroom battle is underway, but signs are the business is on the cusp of better times financially.
Is my March idea to buy the mid cap shares in London-listed, Russia-based gold producer Petropavlovsk (LSE:POG) blown apart by a current battle for board control?
I drew attention at 16p along a rationale of how rising gold prices conflated with Petropavlovsk, the company having completed an extensive period of investment. A high-capacity Pressure Oxidation (POX) hub, operational since end-2018, is one of only two such plants in Russia, and the largest, hence is a game-changer.
Russia has substantial quantities of “refractory ore” containing fine gold particles throughout, which are resistant to standard extraction methods, but which constitute around 60% of Petropavlovsk’s resource base. Also, the company removed its gold price hedges at end-2019, so benefits from recent strength in gold prices.
Ideally positioned for the current environment
A low share price made Petropavlovsk look a typical speculative penny share, and, indeed, “Russia” and “mining” make Petropavlovsk inherently high risk. Yet, I suggested it was potentially high reward also, and by 22 June the price had hit 32p as the company’s dynamics coincided with central banks embarking on a colossal money-creation scheme that raises old fears about debauching currency. Gold is up a further 35% since March, its relatively “inelastic” supply meaning sudden demand boosts the price.
Petropavlovsk shares dropped to 25p after an apparent bid for boardroom control broke at the 30 June AGM, raising fears it could end up as another example of Russian meddling and chicanery. A concert party owning 39% of the company voted the chief executive and finance director off the board (when up for re-election), plus five non-executive directors, including heads of the audit and risk committees, and the senior independent director.
Somewhat oddly at first, Peter Hambro, who had himself previously been removed as chairman, stepped into that role, and the current deputy CEO, Dr Alya Samokhvalova, was promoted to a full CEO role as a director. Two non-executive directors were also appointed. While Samokhvalova is anyway highly qualified and respected in the City of London, this looks to be a stop-gap move by the company, filling a void resulting from the concert party’s voting.
A classic proxy battle as pioneered on Wall Street
Objectively, and in fairness to these Russians, it is American activist investors who perfected this game – exploiting the rise of corporate governance concerns in recent decades, to enrich their (hedge fund) clients. Yet the tactics do raise concerns about imposing key aspects of strategy and/or asset deployment, without paying any premium for control.
The situation at Petropavlovsk appears an attempt for control via the classic “proxy battle” method of shareholder meeting votes, rather than making a financial offer to all shareholders.
These activists came in last October when Fortiana Holdings (Russia’s fifth-largest gold producer) bought a near-5% stake.
Then, early last February, the Uzhuralzoloto Group took an assertive 28% interest, close to what would trigger a mandatory offer to the rest of shareholders under London listing rules. This is another of Russia’s top five producers, with substantial refractory gold ore assets, as if poised to run them through Petropavlovsk’s POX hub. Other Russian companies in the concert party are Everest Alliance and Slevin.
So, it is a positive how they covet the company’s assets, albeit a negative around how the board ructions at the very least result in distraction – for which there has to be some cost.
Plus, an ongoing nagging fear is whether the disruptors could “do a Sibir Energy” – a decade or so ago, this AIM-listed Russia-based company had key assets stripped.
Soon after the AGM there was an initial rebound to 27p, but this didn’t last, and yesterday the price fell 1p, indicating sentiment remains edgy. A price of 25p does appear quite a support point in the trend-line so, if the price falls through that level, it could beget more selling.
Otherwise, a retreat from the surge to 32p looks entirely normal in a chart context. At 25p, Petropavlovsk, capitalised at around £850 million due to over 3.3 billion shares issued, is a substantive business.
Source: TradingView. Past performance is not a guide to future performance.
Operations not compromised by Covid-19
Meanwhile, and despite Covid-19 raising some uncertainties, the company’s operations have not been compromised given its status in Russia as a “continuous process organisation.”
It has also continued to sell gold via Russian commercial banks while Russia’s central bank has suspended gold purchases temporarily.
Despite the chairman’s outlook statement in the 2019 annual report (six weeks ago) citing “some aspects of business more difficult,” albeit full operating capacity is being maintained, I think the macro context of higher gold prices more than offsets Covid-19 disruptive risks.
The (currently demoted) chief executive’s outlook statement was positive, despite lacking specificity, expressing his hope that cash flow will ramp up now the POX hub is re-rating output, thus cutting debt and enabling the dividend to resume.
Price firms after news of rival initiative to restore the board
Petropavlovsk shares inched up 0.5p to 25.5p in early dealings today in response to news confirming that Aurora Nominees, with 11.4% of the equity, has requisitioned a general meeting to re-appoint those directors voted off the board on 30 June – plus two new non-executive directors, as if adding reinforcements. The price has since fallen back.
Given these directors had been deposed by a 39% concert party, chiefly due to the apathy how only 73% of the shareholder base actually voted, once a determined effort gets underway in this proxy fight I wouldn’t be surprised to see their re-appointment.
But whatever the outcome, the POX hub’s technology and engineering is well-established, a competent management team exists beneath board level, and gold price trends are likely a more significant bearing on intrinsic value.
I’d still be concerned as to the motivations of the two oligarchs behind the board coup – Konstantin Strukov of EGC and Nikolai Lustiger of Everest/Slevin – but their actions under-line how Petropavlovsk is becoming a valuable asset.
| Petropavlovsk - financial summary | ||||||
|---|---|---|---|---|---|---|
| Year end 31 Dec | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 |
| Turnover ($ million) | 865 | 600 | 541 | 587 | 500 | 742 |
| Operating margin (%) | 6.0 | -13.4 | 14.2 | 17.1 | 30.0 | 15.6 |
| Operating profit ($m) | 51.7 | -80.1 | 77.0 | 100 | 127 | 115 |
| Net profit ($m) | -261 | -239 | 33.7 | 37.0 | 25.9 | 25.7 |
| Reported earnings/share ($) | -0.34 | -0.07 | 0.01 | 0.01 | 0.01 | 0.01 |
| Normalised earnings/share ($) | -0.30 | -0.06 | 0.01 | -0.01 | 0.01 | 0.01 |
| Operating cashflow/share ($) | 0.31 | 0.03 | 0.01 | 0.04 | 0.07 | 0.13 |
| Capex/share ($) | 0.36 | 0.03 | 0.01 | 0.03 | 0.04 | 0.03 |
| Free cashflow/share ($) | -0.05 | 0.00 | 0.00 | 0.01 | 0.03 | 0.10 |
| Cash ($m) | 48.1 | 28.2 | 12.6 | 11.4 | 26.2 | 48.2 |
| Net debt ($m) | 930 | 610 | 599 | 585 | 568 | 561 |
| Net asset value ($m) | 549 | 493 | 554 | 556 | 601 | 635 |
| Net assets per share ($) | 1.00 | 0.15 | 0.17 | 0.18 | 0.18 | 0.19 |
| Source: historic Company REFS and company accounts | ||||||
Newsflow had otherwise been evolving fairly well
The 2019 results showed a 22% rise in total gold produced, 517.3 thousand ounces; and a 39% rise in total gold sold, 514 thousand ounces, versus a 10% rise in total cash costs. Other numbers were mixed: underlying EBITDA up 45% to $264.8 million, albeit statutory operating profit was up just 9% to $115.4 million and near-flat net profit of $25.7 million despite capital expenditure down 23% to $103.8 million.
The cash flow profile contrasts radically: up 54% to $250.5 million before working capital changes, otherwise down 43% to $189.3 million at the operating level. Such an outcome was relatively historic, however, versus the POX hub ramping up and a modest 7% increase in gold prices in the last financial year.
The shift in expectations going forward is underlined by the usually conservative and backward-looking (in my opinion) S&P credit ratings agency. On 24 June, it upgraded Petropavlovsk’s senior bonds from B- to B, based on expectations that operating performance will stabilise and gold prices remain supportive. Also, the ratio of net debt to EBITDA is expected to be maintained below 2.0.
Broadly a ‘hold’ stance appears fair
No investor appreciates boardroom sagas, and I would expect this one to cap the shares for now. The price did test 25.8p before 9am but has so far settled around 25p again.
Restoring the previous board via an EGM might re-boot confidence, although the disruptors’ tanks can’t be shifted from the lawn.
This development does however signal how Petropavlovsk is on the cusp of better times financially, than typical targets of shareholder activism – where directors are attempted ousted for strategic and/or operational mistakes. Hold.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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